Wednesday, October 22, 2014

SanDisk Corporation offers strong Q3 results for mixed reactions.

SanDisk Corporation reported earnings on October 16th after the bell and dropped sharply in the afterhours (-5%). The stock did not hold any of these losses and made a strong recovery throughout the next few trading days. The company beat UASBIG estimates for revenue and EPS coming in at $1746.5 billion USD and 1.45 dollars per share (non-GAAP), respectively. Our estimates for revenue & EPS were $1699 BB USD & 1.4 Dollars per share, respectively.  Street consensus was around 1.36 for EPS and $1766.9 billion USD (Factset).
The company appeared to have very strong results compared to company guidance and is still on pace to meet its revenue guidance for the year. The company is absorbing the very large acquisition that was made this year very impressively, posting strong net margins and revenues. After a very harsh sell-off the results and guidance this quarter were refreshing. The company is aggressively pursuing market-share in the high growth enterprise storage market and having success here. This will result in a decreased reliance on key customers as this business becomes a larger percentage of sales. This will also allow the company to serve higher margin customers during times of supply constraint, the cited reason for the current pressure on gross margins. Supply constraints cause SanDisk to allocate a larger percentage of sales to high volume – low margin customers in the short term. In the past companies have increased capacity during these cycles and destroyed pricing when product releases and computer sales decreased.
The words “supply constraints” should be music to investor’s ears. Oversupply is arguably the most critical factor in explaining sharp drops in margins for semiconductor companies across the board. We are attracted to the oligopoly structure of the NAND market specifically and the apparent supply constraints that are in effect. The only company who announced severe capacity expansion was Samsung. The nature of the facilities was not announced. It could therefore be NAND flash, DRAM, logic, etc. We perceived this news as irrelevant, but also as part of the reason for the severity of the recent sell-off in SNDK stock. These facilities will not be complete until mid-2017, giving the few competitors at least two more years of pricing power.
SanDisk manufactures its NAND with Toshiba, through a joint venture, and the two announced capacity additions of no more than 5% per year. Micron completed NAND capacity expansions in 2013-2014 and the effect on industry pricing has already run its course. SK Hynix has been using capital to repair facilities after a fire in one of their DRAM plants as well as expand DRAM capacity. The company has not announced capacity expansions in NAND to date. Overall, we believe that most capital expenditures going a couple years out will be to upgrade existing facilities. Every other competitor mentioned must also allocate capital to their DRAM, and logic chip businesses. This decreases the likelihood of them adding capacity to NAND, especially as DRAM demand is spiking and the logic market is mainly controlled by only one key player (Intel).
The company has proven manufacturing excellence and this expertise will carry over in the 3D NAND era of flash memory. A look at reviews/tests on Samsung 3D NAND hard drives reveals that the only advantage is a quicker shut-down time. SanDisk will work together with Toshiba and take the time to leverage this technology for performance improvements and cost savings. Samsung appears to have rushed this technology introduction and we believe SanDisk/Toshiba will enjoy a second-mover advantage. Employees of this partnership are responsible for the original invention of NAND flash memory.

To conclude we believe the stock is highly de-risked, and at an extremely attractive valuation. We believe this stock will be a top performer going into 2015 and any near term weakness should be used as a buying opportunity. The company will continue to grow earnings at an alarming rate after it integrates Fusion-IO with the existing business and unlocks many potential synergies. The supply demand situation in the NAND industry will be favorable for the foreseeable future. We believe that SanDisk Corporation stock will specifically outperform due to improving margins, higher sales growth, and higher EPS growth. We believe that the company can return to non-GAAP gross margins above 50% in the next 12 months due to a more favorable product mix, price stability, and reduced manufacturing costs. Success in the Enterprise storage market will allow SanDisk Corporation to grow sales at a faster rate than competitors. SanDisk is able to finance growth with a very cheap rate on convertible debt. This allows them to use a very high percentage of free cash flow for capital return programs including share buy-backs and dividend issuance. Our current price target is $112 per share.

Tuesday, October 21, 2014

Google Inc. 3Q14 Earnings: Continued Growth Despite Earnings Miss

Google Inc. posted revenues of $16.53 B and non-GAAP EPS of 6.35 dollars per share for Q3 of 2014. Consensus was at $6.53 for EPS and $17.2B for revenue. Revenues were up 20% Y/Y and 4% Q/Q. Geographical growths were strong, with Y/Y revenues up 15% in the US, 17% in the UK, and 26% outside those areas.  

Paid clicks were up 17% Y/Y and 2% Q/Q, a slowdown from 25% in Q2, and cost per click was down 2% Y/Y and flat Q/Q. Sales chief Omid Kordestani attributes this to a normal fluctuation that happens from time to time and is actually the lowest CPC decline seen by Google in the last seven quarters. The cost per click metric is an indicator showing pressure from low smartphone ad prices is abating.

Google sites revenues were up 20% Y/Y, attributed to mobile search, and came in at $11.1 BB. Network revenues were up 9% Y/Y coming in at $3.4 B due to growth in the AdMob and the Ad Exchange business, but was lower than expected. Other revenue increased by 50%, fueled by Google Play and ad licensing, to $1.8B. Free cash flow is at an impressive $3.6 billion, up 28% Y/Y.

Heavy spending was the driver behind the lower than expected EPS with R&D spending up 46%, S&M up 28%, and G&A up 20%. CFO Patrick Pichette stated “it’s the time of year when we do equity refresh”, in regards to heavy opex growth and human resource spending. He says that this is a unique quarter because of this. Traffic acquisition costs (TAC), came in at $3.3 BB, representing 23% of ad revenues. The stock lowered in after-hours trading by 1.25% under the $520 range and dropped below $510 Friday, but has made a good gain in the next week back at $520.

Google’s core business growth has slowed across the board while profitability took a hit due to opex spending. A main factor is that international growth has not been up to par. However the investment seen this quarter should bode well for the future. The long term growth has been supported in areas such as robotics, Android, automation, and internet. There are some exciting upcoming technologies such as the Android One low-cost smartphones, a mobile messaging platform, and Google Fiber Optic. Shares didn't drop too much despite the miss; however the drop off over the month is a cause for concern. Shares dropped nearly 70 points in the past month for a wide array of reasons from competing products to legal battles. This is quite a fluctuation for Google, but a rebound should be in the works. Some investors may be panicking, especially with increased competition in mobile advertising and mobile phones, but the drop is overstated.

Solid growth and strong free cash flow are major contributors to the company’s positive outlook. However consistent estimate misses by Google has become an issue. There has been a growth in these misses over the last quarters. In the last 12 quarters, Google has missed nearly 92% of the time on the top or bottom line. Margins have also decreased, bringing the risk of the business flattening out. We expect margins to increase in the future as expenses drop. We still believe Google is undervalued with strong revenue growth around 20% each quarter and a strong investment into the future over the past months. Expenses should come back to normal levels, but a less than stellar quarter has us scale back our price target. We recommend a hold on the company with a price target around 670.

Thursday, October 16, 2014

Double Down Position on Spirit Airlines (SAVE)

On October 14th, we doubled down on our position with Spirit Airlines (SAVE). Spirit has recently taken a hit in their stock price due to concerns arising from the Ebola virus and capacity concerns. Spirit has airlines that fly to Africa and the worry over loss of business in that region has the street worried about whether this could cause significant impact. In regards to their capacity returns, Spirit recently extended its fleet by about 15 aircraft’s, causing an increase in the supply of seats. Since there has been an increase in supply so suddenly, the demand for the aircraft’s have not been met yet, but we believe this is only due to the fact they were recently added. Spirit’s position is still strong and their business model is intact, which leaves us to believe that this is a great time to double down on our investment.

Wednesday, October 15, 2014

Wolverine World Wide is up 3.2% on mixed 3rd quarter earnings

Wolverine World Wide is up 3.2% on the day since reporting earnings. This is despite earnings that showed mixed results. They have lowered their sales guidance for the year while also missing on sales estimates for the quarter. They now estimate sales to be $2.75 billion for FY 2014 which represents a 2% annual growth down from original expectations of $2.78 billion which would've been 3% annual growth. This revision is due to weakness in US retail as well as weakness in their lifestyle group.

However despite missing sales and lowering guidance they have reaffirmed their full-year earnings guidance and also beat earnings estimates of $.59 adjusted earnings a share reporting $.63 a share. This is the eighth straight quarter that they have beat analyst estimates for adjusted earnings. The primary reason Wolverine was able to beat earnings while coming up short on revenue was due to increased efficiency. They showed a 2.8% year over year decline in operating expenses. This caused operating expenses as a percentage of sales to fall 50 bps and improved operating margin for the quarter by 70 bps. While the investment thesis that the company will begin to grow their margins by cutting costs has proved effective, we need to look for further evidence that Wolverine can start to increase sales in their lifestyle group or we may need to look for an exit opportunity in the near future. 

Tuesday, October 14, 2014

Citigroup Posts Beat on Q3 2014 Earnings

Pre-market Citigroup posted a rise of 6.6% to EPS of $1.15, beating estimates by $.03, excluding one time charges.
Revenue rose 9.5%, to $19.6 billion.

The bank also reported it is exiting 11 poorly performing regions by selling its retail banking branches in: Costa Rica, El Salvador, Guatemala, Nicaragua, Panama, Peru, Guam, the Czech REpublic, Egypt, Hungary, and Japan.  Japan was the only surprising pick, but with the Abenomics form of QE keeping interest rates low in the foreseeable future, it makes sense for Citi to exit the region, inorder to keep their NIM high.
The banks Net Interest Margin to 2.9%
Fixed Income trading revenue rose 5% to $2.98 billion, which has been a soft spot for banks earnings the past year.
Citigroup did however have higher expenses, much in-line with the company's guidance that stress-tests preparation would rise costs. Operating expenses for the quarter rose 5.8%.
Investment banking revenue rose 32%, driven by broad-based strength in the IPO and debt underwriting businesses. Advisory revenue rose 90%.
Shares were up 2.5% in mid-day trading.

Monday, October 13, 2014

Union Pacific taking a hit

   Union Pacific was down 3.22% today to $98.08/share primarily due to the news of a possible merge between their competitors CSX and Canadian Railways.  UNP's share price has taken a hit due to that news and due to the market overreacting to geopolitical news and ignoring the economies steady macroeconomic improvement.  Certain indictors such as increasing job payrolls and a decreasing U.S trade deficit implies the U.S economy is improving. The market has been reacting to the unstable global growth and the Federal Reserve acknowledged that the U.S dollar has been increasing and may hurt exports.  Therefore they are taking that into consideration when deciding when they will increase interest rates in 2015.  All in all Union Pacific's fundamental analysis is still robust and they will be reporting earnings October 23rd.

Saturday, October 4, 2014

Hal Sell Thesis

On Wednesday October 1st Hal fell below our stop loss price of $63. After further evaluation we agree that there has been a fundamental deterioration in both our investment thesis and in the sector as a whole. The oil field services industry has been down recently and Hal has declined near 10% in the month of September. We will continue to monitor Hal and look for a more favorable position to enter this later this year if macroeconomic conditions improve. While Hal still retains its core strengths and strong North American exposure, it simply cannot compensate for systemic issues in its industry at this time.